Why tuition discounting has created more problems than solutions (essay)

Submitted by Frank H. Wu on September 26, 2017 - 3:00am

At last, as evidenced by more colleges and universities performing a tuition reset[1], higher education leaders are awakening to the threat of tuition discounting[2]. The increasing rates[3] by which many institutions have had to cut what they wish to charge students should be cause for public concern. On more than one campus, the overall discount rate has surpassed 50 percent on a sharp trajectory, compared to levels less than half that in recent memory.

The situation is alarming for two independent reasons. First, colleges and universities, even those proclaiming a commitment to diversity, are leaving behind disadvantaged students[4] for their own rise in rankings. Second, they are imperiling their continued existence[5] by reducing revenues to sums below sustainability. Even administrators and board members who are indifferent to accessibility should care about bankruptcy. Tuition discounting is like other bets against the future -- heavily against the odds.

Tuition discounting has been around for some time. But it is being used for very different purposes than previously. Tuition discounting is the practice, on a significant scale, of advertising a list price for enrollment and offering deals that reduce that amount for select students. It is akin to other forms of differential pricing[6] and dynamic pricing[7], responsive to supply and demand in the marketplace.

On a typical airline flight, the passengers on board the airplane have paid various fares to be transported in the same time frame to the same destination. Likewise, at a baseball game or rock concert, the attendees have been charged various prices for essentially the same experience. These policies are customary and not subject to legal challenge. They are not treated with the same suspicion as invidious discrimination on the basis of race or gender.

As with tickets, so too with tuition. Tuition discounting extends these concepts to higher education. As a form of financial aid[8], a tuition discount should not be deemed the same as a scholarship. For marketing purposes, it can be disguised as such, but by any definition, it is another thing altogether. While a scholarship in a strict sense is paid for by donations, either in the form of an endowment-generating income or annual gifts, tuition discounting is unfunded and relies on redistribution of revenue paid by some students as a subsidy to other students.

In the past, tuition discounting was forthrightly progressive. It was intended to allow students to afford college regardless of their wealth (or their family’s wealth). Monies were transferred from individuals with greater means to those with lesser means. An objective formula was used to sort people along a spectrum. Some public institutions, such as the University of California with its “master plan” idealizing higher education for social mobility[9], operate under a legal mandate. They must “return to aid[10]” a percentage of any tuition hike.

Confirming the consensus, colleges and universities prided themselves on being "need blind" in their admissions if they could attain the status. It was a prestigious group. The most elite institutions, with the greatest endowments, were the only ones that could afford to promise applicants that all who were accepted would be able to attend, regardless of resources. The institution would chip in the difference between what the student could reasonably be asked to pay and what the tuition was said to be. Yet it was possible to make the scheme work, even without vast wealth on the part of the institution, by the strategy of tuition discounting. The scale of tuition discounting had to be managed, of course.

Nowadays, however, tuition discounting has transformed itself. The crisis is acute for law schools[11] and liberal arts colleges. They vary considerably in the degree of the predicament, but some competitors will no longer be able to keep up with their rivals for lack of funds.

What happened was that administrators realized they had what looked like the panacea for gaming the system[12]. The rankings emphasize inputs (standardized test scores and grades) over outputs (value added, much more difficult to assess). Set aside the principle of helping out those who need -- and deserve -- helping out. Substitute instead the notion that some who are admitted show more "merit" (even though it is based on approximate predictors) and deserve more -- whether they need it or not -- and you can see how attractive it is to swap the beneficiaries. The grant to the student with financial need is repackaged as the scholarship to the student with merit. The direction of largess is reversed: unbeknownst to both, the needy student is supporting the “meritorious” student. If discovered, this detail is not conducive to their sense of community.

Then another set of factors tipped over the whole system. It would be troubling enough to have to chase students with marginally better profiles. On top of that, some colleges and universities cannot fill their seats[13] -- never mind whether it is with the most attractive candidates[14] or others. That has occurred because of demographic trends, doubt about the return on investment for higher education and the loss of the standby of international students. Thus it is not unheard-of for even reputable law schools to be touting scholarships (meaning, in fact, tuition discounts) to students who would have been rejected outright prior to the application downturn. It is an expedient while awaiting the miracle of bouncing back, an optimism that is repeated as if it the repetition will make it so. Or it’s hoping for the demise of one’s peers, which cannot be uttered aloud.

The phenomenon becomes crazy, because colleges and universities cannot but vie against one another. Supply and demand favors the students over the institutions. It once was vaguely unethical to bargain with students. Today it is expected. So institutions are locked into a mutual ratcheting, what economists would characterize as a "race to the bottom." My colleague across town, for understandable motivations of improving her bottom line, pushes her discount rate a percentage point higher; I am compelled to respond by a percentage point beyond that -- and we're off! The irony is that both she and I can end up with higher tuition, weaker students and, worst of all, even less revenue than before we together walked into the trap. We have less revenue because we cannot raise tuition or enrollment quite enough to cover the mounting deficit [15]from the discount rate.

A Reset Required

Tuition discounting is an addiction. That means that it must be recognized for its risks. Presidents, backed by boards, have to wean themselves off this drug. Among the means of doing so is the equivalent of going cold turkey, the so-called tuition reset. The irony is that an institution that slashes its stated tuition might end up boosting overall revenue by bringing down the discount rate to a greater extent to offset, attracting the students who had been deterred by an exaggerated sense of the cost of attendance, or both. A tuition reset might be the only means of doing a discount rate reset. It has not escaped notice that this move likely will increase the real cost of attendance for at least some students, those who otherwise would have received the former discount rate.

But tuition discounting also is a collective action problem. That suggests that the worst effects can best be addressed through cooperation rather than competition. The "overlap" group discussions among about five dozen of the best colleges[16], and the limited exception from antitrust laws that Congress has already approved[17], provide a potential remedy. The Ivy League and MIT fought a price-fixing lawsuit a generation ago, and, after losing, obtained a congressional reprieve to a limited extent. They had been, and wanted to continue, sharing information about which students were in an “overlap” pool of those holding offers from more than one of the participating schools. The concept was the institutions would meet financial need for that person but otherwise not bid against one another. If colleges and universities could negotiate[18] even further, subject to the requirement that the discussions had to benefit students with financial need (not the institutions themselves), they could “collude” to avoid the acceleration of discount rates.

Above all, what tuition discounting shows is that the business model for higher education is broken[19]. It is priced out of reach for the ordinary consumer. As much as academics flinch at terms such as "business model" and "consumer," the institutions that employ them are selling something to somebody. Middle-class families will not pay the price. They should not have to. Expenditures have to be brought in line with revenues.

To do that, tuition discounting cannot continue. Sooner than later, colleges and universities will be forced to confront this truth. The longer they deny it, the harder the inevitable crash.

Frank H. Wu is a Distinguished Professor at University of California Hastings College of the Law, where he previously served as chancellor and dean. He attracted national attention for initiating strategic class size reduction in 2011.